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Consumption CAPM

Consumption CAPM

When we recently examined Intertemporal Capital Asset Pricing Model (I-CAPM), we understood it to be an extension of CAPM in which investors establish additional portfolios to hedge specific risks representing short-term idiosyncratic tastes and preferences. Typical examples of these specific risks include inflation, job loss, economic downturn, etc. The model is somewhat incomplete, in that it doesn’t specify how to arrive at the proper factors to quantify these additional hedges. Another approach, called the Consumption CAPM (C-CAPM) posits a single additional hedge portfolio based on consumption risk, which is a hedge against future consumption rates.

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Copyright 2011 Eric Bank, Freelance Writer
Capital Asset Pricing Model, Part Three – Other Assumptions

Capital Asset Pricing Model, Part Three – Other Assumptions

In Parts One and Two of our examination of the Capital Asset Pricing Model (CAPM), we evaluated two major assumptions:

1)     Market returns are properly modeled by a normal distribution

2)     Beta (systematic risk) is the sole source of priced risk for an asset or portfolio of asset

As you recall, we found several weaknesses in both assumptions as they may apply to hedge funds. This time, we’ll examine the remaining assumptions underlying CAPM, and see if each is reasonable when applied to hedge fund trading.

CAPM assumes: Continue reading “Capital Asset Pricing Model, Part Three – Other Assumptions” »

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Copyright 2011 Eric Bank, Freelance Writer
Capital Asset Pricing Model, Part Two – Systematic Risk

Capital Asset Pricing Model, Part Two – Systematic Risk

We are reviewing the underlying assumptions made by the Capital Asset Pricing Model (CAPM). Recall from last time the assumption that returns are distributed normally (i.e. a bell-shaped curve) and how this fails to account for skew and fat tails. Today we’ll look at CAPM’s assumption that there is but a single source of priced systematic risk: market beta.

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Copyright 2011 Eric Bank, Freelance Writer